Invesco Perpetual: “ECB support to reduce equity risk premiums”

Even if on-going fears of systemic risk in Europe continue to weigh on European equities, the recent meeting of the governing council of the European Central Bank has been a credible step in reducing some of the tail risks in the region, according to Invesco Perpetual’s European equity team.

“The ECB has indicated its willingness to provide significant financial support to any country which requests assistance, acting alongside the European Financial Stability Mechanism and the European Stability Mechanism. This could help to reduce equity risk premiums for European equities which currently remain extremely elevated relative both to their historic levels and the US market,” said Joel Copp-Barton, European product director at Invesco Perpetual.

According to Copp-Barton, investors have tended to put certainty and low risk at the heart of their investment strategies in recent times, with other areas largely ignored.

“We would argue that depressed valuations already assume a challenging macro environment going forward. More confidence in the ECB and the key policymakers could be supportive generally for European equities, but we believe that some areas of the market have been even more de-rated than the European market as a whole,” he said.

Although much of the detail still needs to be worked through, policymakers’ recent actions are putting in place a framework for addressing the high level of sovereign spreads in peripheral Europe.

According to Copp-Barton, this should provide peripheral governments with time for the structural reforms and fiscal consolidation to make the required progress, with many of these programmes already in place in Spain and Italy.

Reforms could help reduce systemic risk in the eurozone and the high current equity risk premiums.

“Reducing the associated tail risks could see investors start to concentrate on stock fundamentals again as opposed to the political environment,” Copp-Barton said.

Consequently, a greater focus on stock picking by the investment community could help to highlight and close the gap between current share prices and their intrinsic value, even more so for some of the neglected areas of the market.

These include autos, pharmaceuticals and insurance, in particular, which are trading at a significant discount to their long-term averages, as well as companies that have been unjustly punished for being domiciled in peripheral nations.

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